Life Insurance: Back to Basics

The modern insurance contracts that we have today such as life insurance, originated from the practice of merchants in the 14th century. It has also been acknowledged that different strains of security arrangements have already been in place since time immemorial and somehow, they are akin to insurance contracts in its embryonic form.

The phenomenal growth of life insurance from almost nothing a hundred years ago to its present gigantic proportion is not of the outstanding marvels of present-day business life. Essentially, life insurance became one of the felt necessities of human kind due to the unrelenting demand for economic security, the growing need for social stability, and the clamor for protection against the hazards of cruel-crippling calamities and sudden economic shocks. Insurance is no longer a rich man’s monopoly. Gone are the days when only the social elite are afforded its protection because in this modern era, insurance contracts are riddled with the assured hopes of many families of modest means. It is woven, as it were, into the very nook and cranny of national economy. It touches upon the holiest and most sacred ties in the life of man. The love of parents. The love of wives. The love of children. And even the love of business.

Life Insurance as Financial Protection

A life insurance policy pays out an agreed amount generally referred to as the sum assured under certain circumstances. The sum assured in a life insurance policy is intended to answer for your financial needs as well as your dependents in the event of your death or disability. Hence, life insurance offers financial coverage or protection against these risks.

Life Insurance: General Concepts

Insurance is a risk-spreading device. Basically, the insurer or the insurance company pools the premiums paid by all of its clients. Theoretically speaking, the pool of premiums answers for the losses of each insured.

Life insurance is a contract whereby one party insures a person against loss by the death of another. An insurance on life is a contract by which the insurer (the insurance company) for a stipulated sum, engages to pay a certain amount of money if another dies within the time limited by the policy. The payment of the insurance money hinges upon the loss of life and in its broader sense, life insurance includes accident insurance, since life is insured under either contract.

Therefore, the life insurance policy contract is between the policy holder (the assured) and the life insurance company (the insurer). In return for this protection or coverage, the policy holder pays a premium for an agreed period of time, dependent upon the type of policy purchased.

In the same vein, it is important to note that life insurance is a valued policy. This means that it is not a contract of indemnity. The interest of the person insured in hi or another person’s life is generally not susceptible of an exact pecuniary measurement. You simply cannot put a price tag on a person’s life. Thus, the measure of indemnity is whatever is fixed in the policy. However, the interest of a person insured becomes susceptible of exact pecuniary measurement if it is a case involving a creditor who insures the life of a debtor. In this particular scenario, the interest of the insured creditor is measurable because it is based on the value of the indebtedness.

Common Life Insurance Policies

Generally, life insurance policies are often marketed to cater to retirement planning, savings and investment purposes apart from the ones mentioned above. For instance, an annuity can very well provide an income during your retirement years.

Whole life and endowment participating policies or investment linked plans (ILPs) in life insurance policies bundle together a savings and investment aspect along with insurance protection. Hence, for the same amount of insurance coverage, the premiums will cost you more than purchasing a pure insurance product like term insurance.

The upside of these bundled products is that they tend to build up cash over time and they are eventually paid out once the policy matures. Thus, if your death benefit is coupled with cash values, the latter is paid out once the insured dies. With term insurance however, no cash value build up can be had.

The common practice in most countries is the marketing of bundled products as savings products. This is one unique facet of modern insurance practice whereby part of the premiums paid by the assured is invested to build up cash values. The drawback of this practice though is the premiums invested become subjected to investment risks and unlike savings deposits, the guaranteed cash value may be less than the total amount of premiums paid.

Essentially, as a future policy holder, you need to have a thorough assessment of your needs and goals. It is only after this step where you can carefully choose the life insurance product that best suits your needs and goals. If your target is to protect your family’s future, ensure that the product you have chosen meets your protection needs first.

Real World Application

It is imperative to make the most out of your money. Splitting your life insurance on multiple policies can save you more money. If you die while your kids are 3 & 5, you will need a lot more life insurance protection than if your kids are 35 & 40. Let’s say your kids are 3 & 5 now and if you die, they will need at least $2,000,000 to live, to go to college, etc. Instead of getting $2,000,000 in permanent life insurance, which will be outrageously expensive, just go for term life insurance: $100,000 for permanent life insurance, $1,000,000 for a 10-year term insurance, $500,000 for a 20-year term insurance, and $400,000 of 30 years term. Now this is very practical as it covers all that’s necessary. If you die and the kids are 13 & 15 or younger, they will get $2M; if the age is between 13-23, they get $1M; if between 23-33, they get $500,000; if after that, they still get $100,000 for final expenses and funeral costs. This is perfect for insurance needs that changes over time because as the children grow, your financial responsibility also lessens. As the 10, 20, and 30 years term expires, payment of premiums also expires thus you can choose to use that money to invest in stocks and take risks with it.

In a world run by the dictates of money, everyone wants financial freedom. Who doesn’t? But we all NEED financial SECURITY. Most people lose sight of this important facet of financial literacy. They invest everything and risk everything to make more and yet they end up losing most of it, if not all- this is a fatal formula. The best approach is to take a portion of your money and invest in financial security and then take the rest of it and invest in financial freedom.

Ultimately, your financial plan is constantly evolving because you are constantly evolving. You can’t set a plan and then forget it. You need to keep an open eye on your money to make sure it is working hard because that money needs to feed you for the next 20-30+ years that you will be in retirement. You have to know how to feed your money now so that it can feed you later.